ANALYSIS-Dirt-cheap Russian shares still no bargain

by Reuters
Monday, 24 March 2014 08:11 GMT

(Repeats Friday story with no changes)

* $70 billion knocked off Russian shares this month

* MICEX trades at 3.8 x forward PE, a third of emerging equities

* High geo-political risk premium attached to Russian stocks

* Crimea sanctions impact means stocks could fall further

By Sujata Rao

LONDON, March 21 (Reuters) - Around $70 billion has come off the value of the Moscow stock exchange this month in response to the Kremlin's military incursion into Ukraine and its annexation of Crimea, but it would be a brave investor who sniffs a bargain.

Even before the falls, Russian stocks were cheap, but with Western sanctions now threatening growth, company profits and credit ratings, and with Russian President Vladimir Putin apparently ready to put geo-political ambitions above the financial consequences, they could yet get cheaper.

The Moscow stock market trades at around 3.8 times 12-month forward earnings, or a third of broader emerging equities, and are worth only half the book value of their assets, 50 percent down on their long-term average.

"The reason," said ABN Amro Chief Investment Officer Didier Duret, who has no Russia exposure in his 168-billion euro portfolio, "is there is a high geo-political risk premium attached to Russian stocks, and markets are not equipped to deal with that."

Russian energy, mining, financial services and engineering companies have been hit with sanctions in response to the annexation of Crimea, and that could deny them access to global bond and merger deals or even bar them from investment funds.

These compound the systemic risk of an economy dependent on the vagaries of world oil prices.

In the past month, analysts have cut 2014 earnings-per-share (EPS) estimates for Russian firms by 8.5 percent, according to Reuters Starmine data.

Onerous sanctions and an escalation in tensions leaves companies vulnerable to a big earnings hit, Morgan Stanley says, just as during 2008-2009 when EPS slumped 62 percent.

"Given a more severe impact on earnings, potential financial stresses and increasing isolation ... Russian equities could conceivably revisit 2008 trough level valuations," the analysts said, noting the market had traded at a P/E multiple of just 2 back then.


Political risks are par for the course in emerging markets, and some might question whether shares from Russia, a $2 trillion, oil-rich economy with per-capita incomes of almost $15,000, should be cheaper than those in impoverished, politically unstable countries such as Pakistan or Egypt.

But not John-Paul Smith, head of emerging equity strategy at Deutsche Bank, a long-standing Russia bear. Russia is, he says, too dependent on state-run firms - from oil producers to pipeline operators to banks - all of which are often pressed into service to further the Kremlin's agenda.

Russia scores poorly in terms of governance risk compared even with other emerging economies, Smith says, citing "the way the Russian state has used listed companies as vehicles to help achieve broader, political, social and geo-political goals".

Take for instance last year's offer of cheap energy supplies to Ukraine. The deal, a sweetener to dissuade Kiev from a European Union trade treaty, would have forced energy firm Gazprom - and its shareholders - to stomach the price cut.

So big is the problem, Smith reckons Russia should be classed not as an emerging, but a frontier market, a category normally reserved for smaller, less liquid and often poorly governed markets - such as Pakistan.


Notwithstanding the risks, around $20 billion flowed to Russian equities between 2004 and 2010, Morgan Stanley estimates, though around $6 billion has since decamped.

One reason was that for income-seeking funds, Russia's 4 percent dividend yield - the ratio of dividend to share price - is attractive. State-run firms typically pay around a quarter of their profits as dividend - to meet the cash needs of their biggest shareholder, the Kremlin.

Many had also bet that the ultra-low valuations were merely an anomaly that would rectify itself as reforms got underway, rewarding investors. Instead they have fallen further.

In early 2014, Maarten-Jan Bakkum, investment strategist for ING's emerging market funds, owned more Russian stocks than their 5 percent weight in the MSCI index. But he cut his position a while ago and hopes to reduce it further.

"A month ago, even before Crimea, I was asked how I could make a negative case for Russia, given how cheap it was," he said. "My response was: things can always get worse in Russia." (Graphics by Vincent Flasseur and Vikram Subedar; Editing by Will Waterman)

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